MARKET COMMENTARY MONDAY, APRIL 30, 2018 - The Prudent Speculator

MARKET COMMENTARY MONDAY, APRIL 30, 2018
EXECUTIVE SUMMARY

TPS 619 – May Edition of The Prudent Speculator Coming Wednesday
Market Drama – S&P Goes Nowhere
High-Water Mark – CAT Pesimists Fail Basic Arithmetic
Buckingham on Fox Business News – Perspective on 3% Yield on 10-Year Treasury
Myth Debunking – 2-10 Spread Contraction Hardly Fatal for Stocks
Econ News – No Recession Imminent
Earnings – Profit Outlook Remains Strong
Valuations – Prices Down & Earnings Up
Stock News – Updates on MSFT, T, INTC, BHE, DLR, WHR, SHPG, FITB, ONB, GT, ZBH,
RCL & NSC

Market Review

Work is underway on the May edition of The Prudent Speculator. If all goes according to plan,
we expect to publish TPS 619 on Wednesday, May 2, with this month’s issue taking a look at
Market Seasonality as well as Value vs. Growth Performance Comparisons, while we have one
first-time recommendation. We will also be posting a new Target Price listing
to theprudentspeculator.com this evening.

Certainly, there was plenty of drama last week (heck, the Korean War ended, or at least pledges
were made to end it at the historic summit between North Korea’s Kim Jong Un and South
Korea’s Moon Jae-in!), but the U.S. markets ended the five trading days near the breakeven
line. In fact, the S&P 500 actually produced a 0.00% total return. Happily, Value did a little better
than Growth, with the Russell 3000 Value index gaining 0.09%, compared to a 0.27% decline
for the Russell 3000 Growth index, and just about all of the capitalization-weighted broad market
indexes outperformed the Dow Jones Industrial Average. That price-weighted benchmark was
weighed down by sizable losses in high-priced components like 3M and Caterpillar (CAT –
$144.72).

Looking at the construction equipment giant, despite lifting its full-year outlook and reporting
adjusted EPS that were 33% better than consensus analyst estimates, and top-line results that
were easily better than forecasts, shares of Caterpillar plunged on Tuesday, reversing an initial
very positive response to its Q1 financial results release on the now-famous seemingly
innocuous “high-water mark” conference call comment from CAT CFO Brad Halverson.

CAT’s numbers were nothing short of phenomenal as the company reported Q1 adjusted EPS
of $2.82, versus investor expectations of $2.12, while revenue came in at $12.86 billion (est.
$12.04 billion). The biggest driver of the beat was operating leverage, particularly in construction
and mining. Additionally, Caterpillar announced that its backlog of business increased 18%
year-over-year to $17.5 billion.

Looking ahead, in January, Caterpillar provided a 2018 profit outlook range of $7.75 to $8.75
per share, but management just upped its projections by a whopping $2.00 to a range of $9.75
to $10.75, primarily due to growing demand for products and services. The outlook includes
about $400 million of restructuring costs, unchanged from the previous guidance, putting the
revised projection for adjusted profit at $10.25 to $11.25 per share. “Based on our strong first-
quarter results and higher demand across all regions and most end markets, we are raising our
outlook for 2018. We will continue to make targeted investments in expanded offerings and
services, consistent with our strategy for long-term profitable growth,” said CAT CEO Jim
Umpleby.

With the new management projections out well before the conference call started, it would seem
evident that many investors somehow failed basic math – if the mid-point of guidance was
$10.75 and Q1 profits came in at $2.82 per share, that leaves $7.93 of EPS for the balance of
the year, or $2.64 per quarter. We were left shaking our heads at the market reaction, especially
as we chose to boost our Target Price for CAT to $181 on the fantastic Q1 report.

Of course, short-term market movements are often puzzling, so we are very much used to
gyrations that don’t make a lot of sense. For example, there was plenty of ink spilled last week
about the ominous implications of the yield on the 10-Year U.S. Treasury breaking through the
3% level. True, round numbers are psychologically important (and we are now back below 3%),
but the average yield on that benchmark instrument has been 6.20% going back to the 1960s,…

…and as your Editor stated in an appearance last week on Fox Business
News (http://video.foxbusiness.com/v/5776349875001/?#sp=show-clips), recent market history
does not support the assertion that rising rates are bad for stocks,…

…while there has been nothing troubling, on average over the past nearly six decades, about a
3% yield on the 10 Year.

No doubt, anything can happen, and the chart above illustrates that there have been more than
a few negative 12-month-return periods mixed in with the gains, but the weight of the evidence
is overwhelming in favor of staying the course in stocks, no matter the Treasury yield, for those
who share our long-term investment time horizon.

Market history states the same about another bogeyman that caused some consternation last
week, namely the shrinking 2-10 spread and its potential of calling the next recession. To be

sure, when the yield on the 10-Year U.S. Treasury less the yield on the 2-Year U.S. Treasury
has dipped below zero in the past, the economy (as well as the stock market) has often run into
trouble, but the current reading of +0.47% is still a long way from negative,…

…and the historical actual average next-12-month return figures should provide comfort (and
dare we say excitement),…

…while the latest economic numbers were actually upbeat,…

…including the initial estimate of first quarter GDP growth coming in at 2.3%, better than the
expected 2.0%, on Friday.

We respect that economic conditions can change quickly, but we don’t see a recession on the
horizon, and we think corporate profits are poised to grow handsomely this year and next.

Finally, as we said last week, it certainly doesn’t hurt that valuations are generally less
expensive today than they were at the start of the year, as evidenced by the forward earnings
multiple comparisons for a broad selection of TPS companies that announced first quarter
results last week!

Stock Updates

And speaking of Q1 numbers, Chris Quigley and Jason Clark provide updates on a baker’s
dozen of our recommendations…

Computing giant Microsoft (MSFT – $95.82) reported earnings per share of $0.95, versus the
$0.85 estimate, in fiscal Q3 2018. MSFT had sales of $26.8 billion (vs. $25.8 billion est.).
Despite rising more than 3% after hours on Thursday afternoon, shares ‘only’ inched up 0.9% in

Friday’s trading. Microsoft benefitted from solid performance in its cloud computing segment,
with substantial optimism in the unit for the foreseeable future.

CEO Satya Nadella said, “The intelligent cloud and intelligent edge represents a tremendous
opportunity for our customers. It comes with a responsibility to ensure trust in technology. We
are working to instill this trust in three key areas. The first is privacy. We recognize that privacy
is a fundamental human right, and we have consistently acted accordingly. Our success is
grounded in our customers’ success. We have been working towards the May 25th GDPR
implementation date since 2016 with hundreds of engineers across the company working on
end-to-end privacy architecture, and we’ll ensure that all our products and services are GDPR
compliant. For customers, we will provide robust tools backed by our contractual commitments
to help them comply with GDPR. In fact, for most customers it will be more effective and less
costly to host their data in Microsoft’s GDPR-compliant cloud than to develop and maintain
GDPR compliance tools themselves.”

Mr. Nadella continued, “In response to escalating cyber attacks around the world, we are
leading a bold initiative to defend and protect our customers. We recently led a coalition of 34
global technology and security companies in signing the Cybersecurity Tech Accord. The
accord is an important first step by the industry to help create a safer and more secure online
environment for everyone. Finally, we recently established the AI and Ethics in Engineering and
Research Committee at Microsoft to ensure we always advance AI in an ethical and responsible
way to benefit our customers and the broader society. This includes new investments in
technology to detect and address bias in AI systems. Microsoft stands for trust, and this will
continue to be a differentiating focus for us moving forward.”

CFO Amy Hood offered her outlook, “Assuming the macro environment remains consistent,
many of the key drivers of our business should remain intact. Revenue growth will continue to
be driven by the transition to cloud services. And within our commercial business, strong
execution and our differentiated hybrid position should drive continued high teens growth in our

server product and cloud services revenue KPI. Office 365, Dynamics 365 and LinkedIn should
also continue to drive double-digit revenue growth in our Productivity and Business Processes
segment. The gross margin percentage of every commercial cloud service will continue to
improve, with more improvement in Azure IaaS and PaaS consumption-based services and less
improvement in our per user SaaS services. While we expect continued improvement in the
overall commercial cloud gross margin, the revenue mix shift to Azure will moderate the rate of
improvement relative to FY 2018. We will continue to grow our investment and capital
expenditures to meet the growing demand for our cloud services.”

Ms. Hood also noted that the new U.S. tax rules will not help Microsoft much going forward from
their fiscal 2017 rate of 15%, “We continue to expect the full year FY 2019 effective tax rate to
be slightly below the new U.S. corporate tax rate of 21%, with variability across the quarters due
to the mix of cloud versus license revenue and the timing of equity vests.”

While the stock has been on a tear and positive operational momentum seems unlikely to abate
in the near term, and we expect to hold this high-quality name a while longer, we wouldn’t rule
out taking some of our terrific gains off the table as it has swelled again to all-time highs.
MSFT’s valuation, including a price-to-forward earnings ratio of 24.5, isn’t cheap by some
measures, yet we remain attracted to the solid dividend yield near 1.8% and terrific balance
sheet. Analysts, for their part, expect the company’s EPS growth rate to be at least 6% for each
of the next three years, with earnings growing from $3.08 in fiscal 2017 (reported) to an
estimated $4.53 in fiscal 2020. Our Target Price for MSFT has been hiked again to $103.

Integrated telecom services firm AT&T (T – $33.04) posted earnings per share of $0.85, versus
the $0.88 estimate in fiscal Q1 2018. T had total revenue of $38.0 billion, versus the $39.4
billion estimate. Shares fell 6% following the announcement on the disappointing report. CEO
Randall Stephenson did his best to accentuate the positives, “We’re off to a good start in 2018,
both in growing our customer base and in building the world’s premier gigabit network. Our
investment in customer growth and our integrated service offerings helped drive solid first-
quarter subscriber gains across our wireless, video and broadband businesses. We also moved
quickly to deploy FirstNet, and we expect the buildout to accelerate as we go forward. Our fiber
deployments for business and residential customers now pass more than 16 million customer
locations. And we’re set to launch our next-generation DIRECTV NOW platform, which will offer
cloud DVR and an additional video stream.”

In addition to the earnings news, AT&T’s effort to close its merger with Time Warner may be
near its end. The company’s battle with the Justice Department wrapped up in court on
Thursday and closing arguments are scheduled for Monday, April 30. The Wall Street
Journal estimates that the delay in closing has cost AT&T $1.4 billion so far. It’s difficult to
handicap the outcome, and the stakes are as high for consumers as they are for AT&T. The
Justice Department’s primary argument is that such a merger reduces competition. AT&T CEO
Randall Stephenson noted briefly in the analyst call, “After the closing arguments, we’ll wait for
the court’s ruling. Based on the court’s determination, we stand ready to close. Funding is in
place, even after we settle the special mandatory redemption bonds.”

Looking forward, Mr. Stephenson said, “We’re on track to surpass our commitment as part of
the DIRECTV deal to build fiber to 12.5 million customer locations. We now reached more than
8 million locations with fiber and plan to hit 10 million by the end of this year. This is in addition
to the 8 million business locations that we pass today within 1,000 feet with fiber. These 16
million locations and the more than 1 million route miles of fiber in our overall network are the
backbone of our network and our move to 5G. With FirstNet 5G and fiber build, our network
development has never moved at a faster pace. We’re excited about the progress we’re making
and even more excited about where our network will be in a very short time.”

With the uncertainty surrounding the Time Warner merger, we have excluded the benefits of
corporate action until a chance of success becomes clearer. Our Target Price has been trimmed
to $45 for the standalone AT&T. Whether the deal goes through or it is denied by regulators (the
breakup fee from AT&T’s perspective is a paltry (for a deal of this magnitude) $500 million), we
remain fans of T, especially given the forward P/E ratio below 10 and the hefty dividend yield
above 6%.

Semiconductor giant Intel (INTC – $52.73) posted earnings per share of $0.87, versus the
$0.71 estimate, in fiscal Q1 2018. INTC had sales of $16.1 billion (vs. $15.1 billion est.). While
shares initially soared 8% after hours, they gained a paltry 0.7% in Friday’s trading session.
Guidance for 2018 exceeded expectations, with Intel reporting that it expects revenue between
$66.5 billion and $68.5 billion (consensus estimate was $65.1 billion) and adjusted EPS
between $3.66 and $4.04 per share ($3.57 est.).

On the topic of the recent hardware flaws, CEO Brian Krzanich said, “Q1 was Intel’s best first
quarter ever and significantly exceeded the expectations we set in January. Our Client
Computing Group continued to execute well, producing growth within a declining PC market.
And our transformation to a data-centric company accelerated, with our data-centric businesses,
including McAfee, up 25% over the first quarter of last year. The strength of Intel’s business
underscores my confidence in our strategy. What we’re seeing is an unrelenting demand for
compute performance, driven by the continuing growth of data and the need to process,
analyze, store, and share that data. That dynamic benefits our traditional CPU business, and it
reinforces the big bets we’ve made in memory, modems, FPGAs, and autonomous vehicles.
We’re competing to win in our largest collection of addressable market sever. And importantly,
we’re not just competing in these markets. We’re leading and shaping them, as our first quarter
results demonstrate.”

Looking ahead, Mr. Krzanich commented, “Our strategy is working and our investments are
paying off. We are now forecasting the midpoint of the revenue range at $67.5 billion, up $2.5
billion versus our expectations in January. We expect operating margin of approximately 31%,
up 1 point from January, as spending as a percent of revenue drops to approximately 30%.
Versus prior estimates, gross margin will be approximately flat, as broad-based strength in our
business is offset by the higher costs associated with the 10-nanometer volume production shift
to 2019. We now expect a full-year tax rate of 13%, 1 point down versus our prior estimates.
Overall, stronger top line growth, improved operating margins, and a lower tax rate will boost
EPS to $3.85, up $0.30 versus prior estimates.”

While the overnight enthusiasm for Intel curiously didn’t carry over into Friday’s trading, we think
that there’s a lot to be enthusiastic about, despite Intel shares trading near all-time highs. We
continue to be fans of Intel and like the company’s diversified revenue stream, low levels of
debt, forward P/E ratio of 13.8 and 2.3% dividend yield. Our Target Price for INTC has been
boosted to $58.

Electronic manufacturing services firm Benchmark Electronics (BHE – $26.60) posted
earnings per share of $0.41, versus the $0.36 estimate, in fiscal Q1 2018. BHE had revenue of
$608.0 million, versus the $594.0 million estimate. Despite the terrific first quarter numbers and
the recent initiation of a quarterly dividend, shares slipped 9.5% following the announcement
after the company’s guidance disappointed investors. Benchmark expects Q2 2018 adjusted
EPS to be between $0.26 and $0.34 on revenue of $590 million to $630 million. Analyst
estimate midpoints were $0.43 and $635 million, respectively. We note that only two analyst
estimates are available at present in Bloomberg.

Benchmark CEO Paul Tufano stated, “We are making good progress on bookings. Revenue
growth is critical for us to achieve our long-term financial model, and bookings are critical to
revenue growth. In the second quarter, we generated $171 million of the bookings; and of those
bookings, 63% were in our higher-value markets and 37% in traditional markets…We have a

fundamental goal, and that fundamental goal is to help our customers to go to market faster and
more economically. And we view that by bringing rich technical capabilities to them, so we are
collaborating with them to solve complex problems, be able to operate extremely complex
environments and complex product sets and more importantly to work with them as if we’re an
extension of their own internal organizations. To realize this goal, we are focused on a number
of key actions that will leverage our exposure to those companies and provide greater value.”

While guidance obviously was troublesome to short-sighted investors, the company has
exceeded analyst expectations for seven straight quarters so the Q2 bar may be set low.
Further, we like that Benchmark continues to expand its product offerings and that it has been
pushing for growth outside of its original markets. Shares trade with a forward P/E ratio of 17
and we remain very enthused about the balance sheet, which boasts about $10 per share of net
cash. Our Target Price has been cut to $36, but we note that BHE now sports a 2.3% dividend
yield.

Data center REIT Digital Realty Trust (DLR – $107.80) had adjusted FFO per share of $1.61
per share in fiscal Q4 2017 (vs. $1.57 est.). “We have already closed on the sale of seven non-
core assets year-to-date, generating proceeds of approximately $185 million and realizing gains
of a little over $50 million. This consistent execution on our capital recycling program has
prompted us to raise the high-end of our range for dispositions guidance by an additional $100
million, further bolstering our ability to self-fund our 2018 capital plan,” said CEO William Stein.
“In North America, data center construction crews remain active across the primary data center
metros, particularly in Northern Virginia, which is by far the largest and most active metro in the
world. It is also Digital Realty’s largest concentration and we are blessed to have 345
megawatts of state-of-the-art capacity on our two existing campuses, in addition to 180 acres of
strategic land holdings that will support the build-out of another 290 megawatts of future
capacity.”

We think that the buildout of cloud infrastructure around the world creates growing demand for
DLR’s offerings, as major technology companies like Microsoft work to deploy their cloud-based
applications and services. With its 185 data centers in 33 markets, DLR has enhanced metro
area exposure, additional hyper-scale product offerings, cost synergies and external growth
potential via a strong development pipeline.

Mr. Stein added, “The global economic backdrop remains quite supportive and the long-term
secular trends driving data center demand seem to be gaining momentum. The Cisco Global
Cloud Index forecast that the number of hyperscale data centers will nearly double by 2021.
Hyperscale data centers will account for more than half of all installed data center servers by
2021 and traffic within hyperscale data centers will quadruple by 2021. Digital Realty has the
heritage and design expertise to efficiently meet this demand. Cisco also projects that 69% of
the compute and 65% of the data will be housed in hyperscale facilities, which will become the
foundation for the evolution of future ecosystems.”

We like that the company has a broad customer base (more than 2,200 clients; IBM is the
largest at 7.8% of aggregate annualized rent), expected 2018 FFO (a measure of real estate
investment cash flow) of $6.52 per share and a recently increased 3.8% dividend yield. We
remain fond of DLR, especially at the recently discounted quotation, and our Target Price has
been nudged up to $132.

Household appliances firm Whirlpool (WHR – $157.75) posted earnings per share of $2.81,
versus the $2.97 estimate, in fiscal Q1 2018. WHR had sales of $4.9 billion (vs. $5.0 billion
est.). Despite the miss, shares moved up 3.8% following the announcement. The company also
said that it expects 2018 full-year adjusted EPS to come in between $14.50 to $15.50, but
revised its GAAP EPS estimate from $12.45-$13.45 to $12.30-$13.30. WHR expects to
generate cash flow from operations of approximately $1.7 billion to $1.8 billion.

“Earlier today we announced an agreement to sell our Embraco compressor business unit for
approximately $1.1 billion in cash. Embraco is a leading global manufacturer for refrigeration
compressors, which is currently reported at heart of our Latin America segment. And in 2017,
Embraco contributed approximately $1.3 billion in sales with margins approximating the
segment average. The deal is expected to close in early-2019 subject to regulatory approval,”
said CEO Marc Bitzer. “Based on the anticipated closing date, the deal is not expected to have
a material impact on our 2018 financial results. However, we have secured financing in an
amount similar to the anticipated net proceeds from this transaction, which we intend to use
significantly includes share repurchases in the second quarter through a modified Dutch Auction
tender offer targeting $1 billion. The impact of this tender offer is not reflected in the guidance
we issued last night.”

The unknowns surrounding U.S. foreign policy has taken its toll on WHR, at least in part, as
shares have slumped since January of last year. We think that the longer term is bright for
WHR, as we still believe that the company is solidly positioned in the U.S. to capitalize on the
appliance replacement cycle and continued housing recovery, while there is plenty of growth

potential overseas. With analysts still looking for adjusted EPS to grow to more than $19.50 in
2020, we think the current P/E ratio (based on trailing-12-month earnings per share of $13.74)
below 12 is cheap, especially given the recently boosted 2.9% dividend yield. Our Target Price
for WHR is now $229, so we have no plans to participate in the Dutch Auction, whereby shares
will be repurchased at a price not less than $150.00 and not more than $170.00.

Pharmaceuticals firm Shire PLC (SHPG – $161.66) posted earnings per share of $3.86, versus
the $3.57 estimate, in fiscal Q1 2018. SHPG had sales of $3.8 billion (vs. $3.7 billion est.). CEO
Flemming Ornskov, M.D., M.P.H., explained, “We saw solid execution in the first quarter with
7% product sales growth. We continue to advance our strong late stage pipeline including
lanadelumab. And finally, we are making progress on our portfolio optimization and the recent
agreement to sell our Oncology business.” SHPG said it expects to sell the Oncology business
for $2.4 billion to Servier. The decision to offload the business was because management did
not believe it was additive to Shire’s long-term strategy.

Looking ahead, management said it is keeping the 2018 guidance and will update investors
again after the Oncology divestiture. The previously announced guidance for full-year 2018
adjusted EPS was between $14.90 and $15.50.

Dr. Ornskov concluded, “We delivered solid results with 7% product sales growth and good
earnings, while overcoming the impact of generic Lialda in the U.S. We also continued to
progress our pipeline including global filings of lanadelumab. These results reflect our continued
progress in transforming Shire into the leading global biotech company focused on rare
diseases. Approximately 70% of our revenue now comes from products to treat rare diseases
and these products are mainly biologics. Our R&D pipeline is very strong with approximately 40
programs in clinical development. Approximately 70% of these programs are in rare diseases
and several programs have been granted breakthrough therapy and orphan drug designations.”

We continue to believe Shire shares are significantly underpriced, despite a big jump in the last
few weeks. Indeed, Takeda Pharmaceutical, the largest company of its kind in Japan, also

thinks SHPG shares are undervalued and has offered 49 pounds per share for the London-
listed Shire shares. The offer represents a 60% premium on the uninfluenced closing price of
30.70 pounds on March 27. Investors seem skeptical, however, that the deal will get done, as
they closed far from the deal price at 38.94 pounds in London on Friday. In the meantime, its
ADHD franchises will see some potentially important product launches occur in Asia this year,
which could boost the valuation of the business line. Additionally, the continued evolvement of
Shire’s rare disease portfolio should create long-term opportunities. SHPG shares trade at less
than 9 times NTM adjusted EPS expectations and our Target Price for our American Depository
Receipts (1 ADR = 3 Shire shares) now stands at $256.

Shares of Fifth Third Bancorp (FITB – $33.83) rallied more than 7% last week, benefiting from
higher interest rates and a solid Q1 earnings release. The Ohio-based bank posted adjusted
earnings per share of $0.57, beating the average analyst estimate of $0.48 and the $0.37 of net
income in the year-ago period. Not shown in the adjusted numbers, FITB’s Q1 financials
benefited from a revaluation of its Vantiv stake after it merged with Worldpay. Adjusted return on
tangible equity and return on assets both improved during the quarter, climbing to 13.4% and
1.23%, respectively. Additionally, net-interest margin was 16 basis points higher than Q4 2017.

“Our first quarter results were strong and reflected the repositioning of our balance sheet over
the last 24 months to improve the resiliency of our earnings. Our balance sheet continues to
strengthen as evidenced by improving credit quality, strong capital ratios and the level of asset
sensitivity which positions us well in the current rate environment,” said CEO Greg D.
Carmichael. “Expenses were well managed while we continued to invest in our strategic
initiatives. We remain focused on driving improved shareholder returns and achieving our long
term profitability targets.”

We believe FITB is a good regional banking name to own in a diversified equity portfolio. Shares
are trading at less than 14 times forward earnings estimates and carry a dividend yield of 1.9%
(though we expect the company to boost its payout in the next few quarters). Our Target Price
has been boosted to $41.

Regional bank Old National Bancorp (ONB – $17.50) saw its shares jump more than 4% last
week after reporting Q1 financial results that saw EPS set a first quarter record and beat
consensus analyst estimates by more than 16% ($0.34 versus $0.29). The company saw
strength in commercial loans and cut non-interest expenses much more than investors were
expecting.

“Our record start to 2018 was driven by continued strong commercial loan growth, disciplined
expense management, controlled deposit costs and excellent credit quality,” said CEO Bob
Jones. “In keeping with our ongoing focus on improving the operating dynamics of the franchise,
we also announced our decision to sell 10 branches and consolidate an additional 10 branches
throughout our franchise.”

We continue to like ONB and its regional focus on Indiana, Wisconsin, Kentucky and Michigan.
While non-interest income compression was a drag in Q1, the company is working to improve
this area as it efforts to diversify its revenue stream. We view Old National as a quality bank
whose management balances a conservative culture with aspirations for growth. ONB remains
well capitalized and its shares currently yield 3%, while the forward P/E ratio is a very
reasonable 13.5. Our Target Price for ONB has been increased to $23.

Tire maker Goodyear Tire & Rubber (GT – $25.50) continued to experience a bumpy road for
its stock in 2018, dropping more than 5% last week following its Q1 earnings release. Shares
are now down more than 20% for the year, no doubt due to concerns around input costs, but we
think the company turned in a solid first quarter. GT earned $0.50 per share in Q1, versus
expectations of $0.46, on revenue of $3.83 billion that was slightly above consensus analyst
estimates.

While GT saw a bit of volume weakness in the Americas during the quarter, the company also
enjoyed improved performance in Europe, the Middle East, Africa and the Asian Pacific region.
“We are pleased with our first quarter results given higher raw material costs and weaker
demand than we expected in the quarter,” commented CEO Richard J. Kramer. “These results
were highlighted by our performance in the 17-inch-and-larger segment in consumer
replacement, which delivered more than double the industry growth in the U.S. and Europe.”

Goodyear also recently announced a joint venture with Bridgestone from which it expects to
soon benefit. Under TireHub, a leading national tire distributor in the United States, the new
venture will allow the company to work more closely with its customers and deliver an enhanced
brand experience for consumers as buying habits continue to evolve. “TireHub will deliver best-
in-class service for our retail and fleet customers and will be the cornerstone of our aligned
distribution network, including our company-owned retail stores,” explained Mr. Kramer.
“TireHub will strengthen our ability to promote our premium brands, our industry-leading e-

commerce solution and our strategy of targeting the industry’s most profitable, large rim size
segments. This agreement increases our confidence in delivering on our long-term targets.”

The company reaffirmed its 2018 segment operating income guidance of $1.8 to $1.9 billion,
excluding the TireHub transition, and confirmed its 2020 segment operating income target of
$2.0 to $2.4 billion. Given all of the above, we think the 2018 sell off of GT shares is very much
overdone. Shares are trading at an unbelievably low forward P/E ratio (based on NTM adjusted
earnings forecasts) of 6.7, and earnings are projected by analysts to grow to $3.59 this year, up
from $2.93 in 2017. What’s more, current EPS estimates for 2019 and 2020 stand at $4.23 and
$5.04, respectively.

While overall vehicle demand is solid (which benefits GT’s business that provides tires to car
manufacturers), we continue to believe that the stock should be more sensitive to overall miles
traveled than to auto sales, given that the company also benefits from its replacement tire
business. We feel that continued strong employment, rising wages and solid consumer
sentiment are conducive to folks traveling more and thereby creating more wear and tear on
tires (spurring replacements). We think that Goodyear also should gain from higher long-term
demand in emerging markets. With management remaining focused on reducing expenses,
improving cash flow and strengthening the balance sheet, our Target Price for GT is now parked
at $47.

Shares of Zimmer Biomet Holdings (ZBH – $116.92) jumped almost 6% last week after
reporting Q1 results that topped analyst expectations on both the top and bottom lines. The
medical device maker said it had adjusted EPS of $1.91, versus estimates of $1.89. Revenue
for the quarter came in at $2.02 billion, compared to expectations of $1.98 billion. While the
knee replacement market slowed during the quarter, ZBH’s share loss definitely decelerated.

“As expected, in the first quarter our performance continued to reflect supply headwinds
associated with key brands within our Knee, Hip and S.E.T. portfolios, as well as the ongoing
quality remediation work at our Warsaw North Campus facility,” said CEO Bryan Hanson. “As
we look out over the course of the next 18 to 24 months, we will stay laser-focused on taking the
necessary actions to narrow our gap to market and drive sustained shareholder value. These
actions include successfully driving our ongoing quality remediation program, restoring supply,
and scaling up the commercial launch of compelling new technologies, all of which remain on
track.”

ZBH now expects full-year 2018 diluted earnings per share in a range of $7.60 to $7.80 on an
adjusted basis. Management believes the company will generate free cash flow between $1.1
billion and $1.3 billion this year. Additionally, the firm is projecting an adjusted tax rate between
18.5% and 19.5%. We continue to like that Zimmer is by far the king in hip and knee implants
and we believe favorable demographics, which include aging “Baby Boomers” and increasing
obesity rates, will drive solid demand for large-joint replacement. Additionally we like that
Zimmer has a history of strong relationships with the orthopedic surgeons that use its products.
The doctors in this specialty have frequently shown resistance to efforts by hospitals or health
systems to limit their ability to choose their brand. We still believe that bottom-line growth will
pick up over time and we like that ZBH consistently generates strong free cash flow. ZBH
shares currently trades at 15 times NTM adjusted earnings projections and our Target Price is
now $169.

Despite reporting record first quarter earnings and increasing its full year 2018 guidance, shares
of Royal Caribbean Cruises Ltd (RCL – $111.82) dropped more than 6% last week (and the
stock is down more than 17% since its late-January high). The cruise line operator announced
that it earned $1.09 per share in Q1, versus consensus analyst estimates of $0.97. RCL
generated revenue of $2.03 billion, slightly lagging forecasts calling for $2.04 billion.

“This year is proving to be another strong year with all our brands firing on all cylinders,”
proclaimed CEO Richard D. Fain. “The market continues to support our growth as our people
keep focused on delivering our targets and goals. The strength of this market plus our new
ships in 2018 (Symphony of the Seas, Azamara Pursuit, Mein Schiff 1 and Celebrity Edge),
position us nicely for 2019 as well.”

The company raised its forecast of full year adjusted EPS to a range of $8.70 to $8.90 per
share, $0.15 better than its previous guidance, as bookings for 2018 have been better than last
year’s record high and ahead in both volume and rate. “We are delighted to report another
record breaking quarter and to be driving towards record earnings for the year, above our initial

guidance,” said CFO Jason T. Liberty. “Revenues continue to excel and expenses, even
including some new demand generating initiatives, continue to be carefully controlled.”

While RCL and its competitors will have to continue to deal with elevated fuel prices, we think
the headwind is reasonably under control as the company hedges 50% of its fuel costs. We
believe the recent weakness is overdone and provides good opportunity to buy the stock as we
remain fans of RCL and the overall prospects of the cruise industry, especially given favorable
demographic and cruise-pricing trends. Shares trade for an attractive 12.5 times projected next-
12-month earnings with a dividend yield of 2.2%. Our Target Price has steamed ahead to $149.

Shares of Norfolk Southern (NSC – $146.62) climbed more than 7% last week following a solid
Q1 earnings release. The East Coast rail transportation company posted adjusted EPS of $1.91
(vs. $1.77 est.). NSC also said it had sales of $2.72 billion, versus the $2.68 billion estimate.
Norfolk grew first-quarter operating income 10% as the firm expanded its top line 6% and held
operating expenses to an overall moderate increase (largely due to operating with 1,000 fewer
employees than a year ago), while benefitting from a lower overall tax rate.

“We are pleased with the continued improvement in our financial performance and the growth in
our business,” stated CEO James A. Squires. “We are focused on improving service for our
customers to position us for future growth and efficiency that will benefit both our customers and
shareholders. The outlook for 2018 is promising, and we are increasing our expected annual
share repurchases to $1.5 billion, confident that we will deliver strong financial performance.”

While shares are currently trading at 17 times NTM adjusted earnings projections for full-year
2018 of $8.62, forecasts for 2019 and 2020 adjusted EPS are currently pegged at $9.52 and
$10.21, respectively. We have chugged along our Target Price to $173.

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